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The Power of Compounding - Compound Interest
"Compounding interest is the greatest mathematical discovery
of all time". Albert Einstein
There is a story about an Emperor of China who was so excited
about the game of chess that he offered the inventor of the game one wish. The inventor replied that he wanted
one grain of rice on the first square of the chess board, two grains on the second square, four on the third and
so on through the 64th square. The unwitting emperor agreed to the modest request. But two to the 64th power is
18 million trillion grains of rice - more than enough to cover the entire surface of the earth. The Emperor, realizing
that he had been duped, had the inventor of the game beheaded.
Eighteen million trillion is a huge number. I personally can't even picture the number of zero's after the 18 in
my head. I'm sure that many people are overwhelmed by the thought of retirement and think that they need eighteen
million trillion dollars in their RRSP to retire comfortably.
This is not the case. A comfortable retirement is within the grasp of most of us provided that we start early and
use compounding to our favour. A real life example illustrates this.
I recently answered an email from a visitor to my site http://www.rrsp.org who was very concerned that she would not have enough to retire with. It was
her goal to have enough money at age 60 to pay herself $50,000 per year. She was 33 years old, had $50,000 in an
RRSP and planned to contribute $5,000 per year until age 60. Fortunately I built a simple spreadsheet for these
kind of questions. Let's look at the numbers assuming a 10% growth rate:
Growth Rate: |
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10% |
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Opening Balance: |
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$50,000 |
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Yearly Increment: |
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$5,000 |
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Age |
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33 |
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|
|
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|
Yr |
Age |
Open Bal |
Increment |
Sub-Total |
Closing Balance |
|
1 |
33 |
$50,000 |
$5,000 |
$55,000 |
60,500 |
|
2 |
34 |
60,500 |
$5,000 |
$65,500 |
72,050 |
|
3 |
35 |
72,050 |
$5,000 |
$77,050 |
84,755 |
|
4 |
36 |
84,755 |
$5,000 |
$89,755 |
98,731 |
|
5 |
37 |
98,731 |
$5,000 |
$103,731 |
114,104 |
|
6 |
38 |
114,104 |
$5,000 |
$119,104 |
131,014 |
|
7 |
39 |
131,014 |
$5,000 |
$136,014 |
149,615 |
|
8 |
40 |
149,615 |
$5,000 |
$154,615 |
170,077 |
|
9 |
41 |
170,077 |
$5,000 |
$175,077 |
192,585 |
|
10 |
42 |
192,585 |
$5,000 |
$197,585 |
217,343 |
|
11 |
43 |
217,343 |
$5,000 |
$222,343 |
244,577 |
|
12 |
44 |
244,577 |
$5,000 |
$249,577 |
274,535 |
|
13 |
45 |
274,535 |
$5,000 |
$279,535 |
307,488 |
|
14 |
46 |
307,488 |
$5,000 |
$312,488 |
343,737 |
|
15 |
47 |
343,737 |
$5,000 |
$348,737 |
383,611 |
|
16 |
48 |
383,611 |
$5,000 |
$388,611 |
427,472 |
|
17 |
49 |
427,472 |
$5,000 |
$432,472 |
475,719 |
|
18 |
50 |
475,719 |
$5,000 |
$480,719 |
528,791 |
|
19 |
51 |
528,791 |
$5,000 |
$533,791 |
587,170 |
|
20 |
52 |
587,170 |
$5,000 |
$592,170 |
651,387 |
|
21 |
53 |
651,387 |
$5,000 |
$656,387 |
722,026 |
|
22 |
54 |
722,026 |
$5,000 |
$727,026 |
799,729 |
|
23 |
55 |
799,729 |
$5,000 |
$804,729 |
885,202 |
|
24 |
56 |
885,202 |
$5,000 |
$890,202 |
979,222 |
|
25 |
57 |
979,222 |
$5,000 |
$984,222 |
1,082,644 |
|
26 |
58 |
1,082,644 |
$5,000 |
$1,087,644 |
1,196,409 |
|
27 |
59 |
1,196,409 |
$5,000 |
$1,201,409 |
1,321,549 |
|
28 |
60 |
1,321,549 |
$5,000 |
$1,326,549 |
1,459,204 |
It's hard to imagine a scenario where this person would not be able to withdraw $50,000 per year with this kind
of money accumulated. In fact, this is what would happen to age 69 taking out $50,000 per year:
Growth Rate: |
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10% |
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Opening Balance: |
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$1,420,954 |
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|
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Yearly Increment: |
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-$50,000 |
|
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|
Age |
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61 |
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|
Yr |
Age |
Open Bal |
Increment |
Sub-Total |
Closing Balance |
|
1 |
61 |
$1,420,954 |
-$50,000 |
$1,370,954 |
1,508,049 |
|
2 |
62 |
1,508,049 |
-$50,000 |
$1,458,049 |
1,603,854 |
|
3 |
63 |
1,603,854 |
-$50,000 |
$1,553,854 |
1,709,240 |
|
4 |
64 |
1,709,240 |
-$50,000 |
$1,659,240 |
1,825,164 |
|
5 |
65 |
1,825,164 |
-$50,000 |
$1,775,164 |
1,952,680 |
|
6 |
66 |
1,952,680 |
-$50,000 |
$1,902,680 |
2,092,948 |
|
7 |
67 |
2,092,948 |
-$50,000 |
$2,042,948 |
2,247,243 |
|
8 |
68 |
2,247,243 |
-$50,000 |
$2,197,243 |
2,416,967 |
|
9 |
69 |
2,416,967 |
-$50,000 |
$2,366,967 |
2,603,664 |
The minimum RRIF withdrawal is about $128,000, or about two and a half
times the $50,000 that she was hoping to withdraw. This is an enviable position to be in.
If you have microsoft Excel, you can access the spreadsheet that performed these calculations here: http://www.rrsp.org/spreadsheets.htm
- click on the "Investment Growth" link. Have fun - Doug Hudson.